Cost classification: capital cost, recurrent cost, fixed cost, variable cost, intangible cost,

components of cost of production: fixed cost, variable cost, total cost, marginal cost, average
cost, unit cost, cost estimation allocation of overhead costs. valuation of cost present value(PV),
BEP
capital cost:
• cost of vehicle, X-ray machine, building, long term training, equipment's (> 100US$)
-Vehicles: bicycle, motor-cycle, four-wheel-drive vehicles, trucks
-Equipment: X-ray machine, microscope, other equipment with a unit cost (price) of US$ 100 or
more
- Buildings, space: Hospital, health centers, administrative office, storage facilities
- Training: training activities for health personnel that occur only once or rarely
- Social mobilization, non recurrent: social mobilization activities, e.g. promotion, publicity
campaigns that occur only once or rarely
• Capital costs are the costs to purchase capital assets that will provide services for more than
one year.

• Two major types of capital items

Land
Equipment

• There are two components of capital cost:

opportunity cost of the funds tied up in the capital, and
depreciation of the capital item itself.

• In costing, we assume that land does not depreciate but equipment depreciates with time and
use.
Recurrent Costs:
• Personnel (all type): supervisors, health workers, administrators, technicians, consultants,
casual labors
• Supplies: drugs, syringes, slides, small equipment (unit cost of less than US$ 100)
• Vehicles, operation and maintenance: petrol, diesel, lubricants, tyres, spare parts,
registration, insurance
• Buildings operation and maintenance: electricity, water, heating, fuel, telephone, telex,
insurance, cleaning, painting, plumbing, roofing, electricity supply/appliances
• Training, recurrent (e.g. short in-service course)
• Social; mobilization: operating costs
• Other operating costs not included above
Recurrent Costs
• From budget numbers or analyzing personnel appointments, salary and benefits of the
personnel working in the clinics.

• Maintenance and other costs for vehicles, equipment and building (gas for the vehicles,
utility bills).

• Drugs and medical supplies

• Storage and other transportations (not included in vehicle costs and building costs above)

• Short-term training and office supplies.

Identification of Costs
Cost Classification
Fixed Cost Capital Cost
Variable Cost Recurrent (Operating)Cost

Direct Cost Direct to Activity

Indirect Cost Indirect to Activity

Tangible Cost Implicit Cost

Intangible Cost Explicit Cost
fixed cost, :
• Fixed Cost (FC) = Costs which do not vary with the quantity of output produced.
• Fixed costs function are costs that have to be met no matter how much or how little of the
commodity is produced: that is, they do not depend on the level of production.
Examples: rents, interest on loans and bonds,
Variable Cost:
• Variable Cost (VC) = Costs which vary with the level of output.
• Variable costs are costs depend on the level of production, that is, on the amount of
commodity produced.
Examples: Material costs labor costs
The Components of cost of production:
Two components:

a) Fixed cost (FC)

b) Variable cost (VC):

Material costs
Personnel costs
• Fixed Cost (FC) = Costs which do not vary with the quantity of output produced.
• Variable Cost (VC) = Costs which vary with the level of output.
Example:
• Cost of hospital infrastructure, equipments, etc are fixed cost of producing health
services.
• Variable cost includes expenditure on salary, wages, drugs, food, supplies, fee for
Total Costs:
• Total Cost (TC) = Fixed Cost (FC)) + Variable Cost (VC)
Calculating Total Cost
L Q FC VC TC
0 0 30 0 30
1 50 30 10 40
2 90 30 20 50
3 120 30 30 60
4 140 30 40 70
5 150 30 50 80
Marginal Cost (MC):
Marginal Cost
• sometimes called incremental cost- increase in cost that result from producing one extra unit
of output.
• Fixed cost does not change as firm’s level of output changes, marginal cost is equal to the
increase in variable cost or the increase in total cost that results from an extra unit of output.
Marginal Cost (MC) = Change in variable cost/change in output level = VC/Q
MC = Change in total cost/change in output level = TC/Q

Average Cost :
• Average Cost (AC) = TC/Q
• Average Fixed Cost (AFC) = FC/Q
• Average Variable Cost (AVC) = VC/Q
Activity Heating, Staff Material Total Average Margin
Level Rent, Cost : Drugs, Cost Cost al Cost
Lightin food,
g and and
Mainten Laundry
ece
20 50 80 200 330 16.5 0
30 50 80 220 350 11.6 2
40 50 100 240 390 9.75 4
50 50 100 260 410 8.2 2
 Exercise
Rate of Fixed Variabl Total Margin Average Average Average
output Cost Fixed variable Total
e Cost cost al Cost
Cost Cost Cost
Q FC VC TC MC AFC AVC ATC

0 50 0
1 50 50
2 50 78
3 50 98
4 50 112
5 50 130
6 50 150
7 50 175
8 50 204
9 50 242
10 50 300
Five Different Cost Curves
• Total Cost (TC)
• Average Total Cost (ATC = TC/Q)
• Average Fixed Cost (AFC = FC/Q)
• Average Variable Cost (AVC = VC/Q)
• Marginal Cost (MC = TC/ Q)
Unit cost:
• After identifying all possible costs and outputs to the programme, we can calculate unit cost
of programme.
• A unit cost is a kind of simple average- the cost per unit of output.
• Unit Cost = Total Cost/Quantity Output
Unit Cost of Program Outputs
• To find the unit cost of a program, we need to allocate the shared
costs to all the departments that use the services of overhead.
• The unit cost provides us an estimate of full cost so that all resources
used for the production process are accounted for.

• Overhead costs are allocated to departments based on some specific

measures, known as “allocation basis”.
• Allocation basis should reflect the use of overhead by the department
and/or program we are costing.
Calculating Cost:
Basic aim should be:
• To identify all the inputs to health care process
• Quantify them in order to attach monetary value
cost estimation allocation of overhead costs:
• Once the relevant range of costs has been identified the individual items must be measured
and valued. That is, costing has two elements:
a) Measurement of the quantities of resource use (q)
b) The assignment of unit costs or price (p)
• Market prices - for many of the resource items, the approach of costing is to take existing
market price unless there is particular reason to do otherwise.
Overhead Costs or The Shared Costs
• Overhead costs it is an accounting term for the resources that serve many
different departments and programs.
• Public health administration
• General hospital administration
• Central laundry
• Medical records
• Cleaning
• Utilities

• If we are costing a specific program, we need to cost the overhead. Although

it exists for running the whole entity, without the overhead cost, the program
can not continue.
How to Apportion Overhead Costs?
• No simple method exists for allocating the overhead costs.

• Marginal analysis: to find out whether the overhead costs will change if
we add or subtract the program or project from the overall activity of
the entity.

• Often it is not possible to estimate the marginal overhead costs.

• Also, we face the problem of choice among programs and the scale of
operation of the programs rather than adding or subtracting.
Allocation Rationale
• The more important the cost item is for the analysis, the greater the
effort that should be made to estimate it accurately.

• Sometimes average costs are sufficient.

• per diem
• average daily medical cost

• If more detailed consideration of cost is needed, various cost-

allocation approaches are available.
Allocating Overhead Costs
• Method 1: Ignore the overhead.

• Method 2: Direct allocation.

• Method 3: Step-down allocation.

• Method 4: Step-down allocation with iterations for full adjustment for interaction of
overhead departments.

• Method 5: Simultaneous allocation.

• Gives the same answer as in method 4.
Example: Neonatal Intensive Care
Unit
• We want to estimate unit cost of NICU, which is located within a larger facility.

• We need to get data on quantities and types of all the services provided.

• Assume that the services are:

• hospital stay
• laboratory tests

• So, we need data on length of stay in NICU, number and types of laboratory tests done.

• Identify the overhead departments that contribute towards the services provided in the
NICU.
Assumptions
• There are only three departments
• Administration
• Housekeeping
• Laundry

• Need to determine unit of output for these departments.

• Cost per patient =
• Cost per unit of output multiplied by
• Usage of each patient of this output

• Unit of output must be as homogenous as possible and available for each patient.
Units of Measurement
• Hospital stay in NICU
• patient-days

• Laboratory work
• identify types of tests done in the laboratory, and
• estimate a common measurement unit, say, workload measurement unit
(WMU).

• If we know the combination of lab tests produced, we can calculate

the WMU produced.
Allocation basis
• Select the allocation basis for each of the overhead departments relevant for
NICU.
• Administration: paid hours
• Housekeeping: square feet of floor space
• Laundry: pounds of laundry

• Using the allocation basis, overhead costs can be allocated to NICU.

• Each overhead cost will be allocated to the departments receiving in proportion

to the allocation basis or common unit of measurement.
• e.g. housekeeping costs will be allocated to departments receiving housekeeping services in
proportion to its square footage of floor space.
Method 1: Ignore Overhead
•In the table, find the cost per unit of output
assuming that the overhead cost does not exist.
• Laboratory cost/WMU.
• NICU cost/patient-day.

• Clearly, it is not a good estimate of full cost of

producing the services.
Method 2: Direct Allocation
• Use sum of final
departments as the
allocation denominator.

• Laboratory cost =
• direct laboratory cost +
• laboratory’s share of
admin cost +
• lab’s share of
housekeeping +
• lab’s share of laundry.

• Cost/unit = laboratory
cost/output
• Similar method for NICU.
Method 2: Direct Allocation
Method 3: Step-down
• Allocates support
allocation
costs to other support
departments and to
operating
departments that
partially recognizes
the mutual services
provided among all
support departments

• One-Way Interaction
between Support
Departments prior to
allocation.
Method 3: Step-down allocation

= 1,500,000 + 214,286

= 1,300,000 + 142,857 + 17,904

Method 3: Step-down allocation

2,800,000

• 3/28 = 300,000 / 2,800,000

Method 4: Step-down w/ Iteration
•Allocates support
department costs to
operating
departments by fully
recognizing the
mutual services
provided among all
support departments.

• Full Two-Way
Interaction between
Support Departments
prior to allocation.
Method 4: Step-Down w/ Iteration
METHOD 5:
SIMULTANEOUS
ALLOCATION

 Uses same data.

 Solves a set of
simultaneous linear
equations.

 Gives same answer as

Step-down allocation
w/ iterations.
 Less work 
Choosing Between Methods
• Methods 4 and 5 are the most precise.
• Step-down w/ Iterations
• Simultaneous Allocation

• Direct and Step-Down are simple to compute and understand.

• Direct Method is widely used.

Cost Determining Components
Inputs Components that determine the
cost
Vehicles Distance traveled/time used
Equipment Time used
Building space Time used/space used
Personnel Time worked
Supplies Weight/volume
Vehicles:operation and Distance traveled/time used
maintenance
Building: operation and Time used/space used
maintenance
Other inputs Miscellaneous
Criteria for allocation of
overhead costs:
Types of Services Allocation Criteria
Space for clinic Square meter (Square meter taken
and /or office up by program divided by square
meter taken by all clinics) x
building cost (depreciated)
Space (Square meter)

Utility Services (Cleaning, (Square meter taken up by program

Heating, Lighting, etc) divided by square meter taken by
all clinics) x Departmental cost

Administration Number of cases

(Number of cases registered to the
program divided by total number
of cases registered at all clinics) x
departmental cost
How are values imputed for non-market
items?

• The major non-market resource inputs to health

care programmes is volunteer time. One approach-
valuation - to use market wage rate.
• What to do with donated goods and services?
Valuation of costs

• In economic evaluation, all the goods and

services should be valued as economic price.
• Shadow pricing could reflect the social price.
• The cost of imported goods should be valued
using shadow exchange rate.
• Capital items should be annualized.
• In case of life time-over capital items, it should
be replaced by market price.
• Donated goods and services- use market price
Economic Cost of Capital Items ,present
value(PV )
• Present Value of item, Pt = Po (1+ r)t
Where Pt = Present Value, Po = Purchase price,
r = discount rate, t = years since purchase
• Annualization factor = (1/r) [1 - (1+r) –n ]
r = discount rate, n = life time of capital item
• Discount factor = (1+r) –n
• Annual cost: Annual cost of capital items can be
calculated dividing Present value of item by
annualization factor.
Break-even Point (BEP):
• The break-even point (BEP) is the point at which
cost or expenses and revenue are equal: there is no
net loss or gain, and one has "broken even."
• A profit or a loss has not been made, although
opportunity costs have been "paid," and capital has
received the risk-adjusted, expected return.
• In short, all costs that needs to be paid are paid by the
firm but the profit is equal to 0
The Break-Even Point
For example, if a business sells fewer than 200 tables each
month, it will make a loss; if it sells more, it will make a profit.
With this information, the business managers will then need to
see if they expect to be able to make and sell 200 tables per
month. If they think they cannot sell that many, to ensure
viability they could:
• Try to reduce the fixed costs (by renegotiating rent for
example, or keeping better control of telephone bills or other
costs)
• Try to reduce variable costs (the price it pays for the tables by
finding a new supplier)
• Increase the selling price of their tables.
Any of these would reduce the break-even point. In other words,
the business would not need to sell so many tables to make
sure it could pay its fixed costs.
Purpose

• The purpose of break-even analysis is to provide a rough

indicator of the earnings impact of a marketing activity.

• The break-even point is one of the simplest yet least used

analytical tools in management. It helps to provide a
dynamic view of the relationships between sales, costs, and
profits. For example, expressing break-even sales as a
percentage of actual sales can give managers a chance to
understand when to expect to break even (by linking the
percent to when in the week/month this percent of sales
might occur).

• The break-even point is a special case of Target Income

Sales, where Target Income is 0 (breaking even). This is very
important for financial analysis.
 Class work
Imagine you have asked to plan a vaccination
program for a district. You want to vaccine all
the children in the district. List all the costs that
you can anticipate, including those borne by
the health service and also those borne by the
patients. For each cost identify who will have
to bear the cost.
Also,
Calculate Cost per Child Fully Immunized
Thank you